When planning your federal retirement, you’ll need to calculate your FERS pension and should request an estimate from your HR. But often, these projections don’t represent what will actually be deposited into your bank account. The reason for this discrepancy is that most individuals calculate their gross pension, not their net pension, and even your pension estimate may not include all the deductions that should be considered. Knowing the difference between your gross pension and your net pension is critical since your retirement income is based on your net pension, and overestimating your pension could mean a cash shortfall in retirement. Read on for the three most common pension deductions you might need to consider when calculating your net pension.
1. The Survivor Annuity Cost
As I’ve covered in previous articles, when you retire, you’ll have the option of providing a survivor annuity for your beneficiaries (aka the Survivor Benefit). This benefit allows your spouse or someone with an insurable interest (depends on you financially) to receive a portion of your pension every month after you die. However, this benefit is not a free lunch and, if elected, will permanently reduce your pension.
The amount of the reduction depends on the survivor annuity you choose. If you elect the full survivor benefit, which provides your survivor with 50% of your unreduced monthly pension for the rest of their life, your pension will be permanently reduced by 10%. Whereas if you elect the reduced survivor benefit, your survivor will only receive 25% of your unreduced monthly benefit, but your pension will suffer a smaller reduction of 5%.
An important point to note is that if you are married, the law requires you to provide a full survivor annuity for your spouse, so if you elect a reduced survivor benefit or none, you will need your spouse’s written consent. Another factor to consider is that if you provide a survivor benefit to someone other than your spouse or former spouse, the selection is an insurable interest. To elect an insurable interest, you must be in good health, and the cost can be significantly more than the spousal benefit. For more details on the insurable interest option, read this article.
Many federal employees don’t realize that about 95-99% of their pension will be taxable income. The 1-5% that is not taxable is due to a return of your FERS contributions made over the years. So, taxes will have a significant impact on your retirement income and must be factored in. Most federal employees I have worked with pay an effective rate* between 15-20%, but everyone’s situation is different. Also, depending on your state, you may need to include state income tax when calculating your net pension.
*The percentage of your income paid in taxes.
Maintaining your Federal Employees Health Benefit (FEHB) coverage in retirement can help keep your medical cost from skyrocketing during a period when you’ll likely need more health care services. But you’ll have to remember to factor in the FEHB premiums when calculating your net pension. Although you’ll probably see a slight increase in your FEHB premiums since you’ll be paying on an after-tax basis, you shouldn’t see a significant difference from what you were paying before you retired.
Putting It All Together
Now let’s look at an example of how your gross pension can be very different from your net pension. For our example, we’ll look at our favorite fed Bob:
As you can see from this example, the net pension was nearly 50% of the gross pension. While everyone’s situation is unique, this example makes it clear that planning your retirement using your gross pension can result in a significant cash flow problem. On the bright side, there are some deductions that will disappear in retirement (at least from your pension, that is), such as the Social Security tax, Medicare tax, TSP contributions, and FERS contributions.
Knowing what your actual retirement income will be is critical to having the retirement you want and avoiding an unpleasant surprise down the road. So, once you know your gross pension take note of which deductions are relevant to you and calculate your net pension. Although we reviewed the three most common deductions, four others may also apply to you (FEGLI, FLTCIP, FEDVIP, and the early retirement reduction). Lastly, consult with a qualified financial planner if you don’t feel confident in creating your financial plan or want a professional opinion.
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2023 Legislative Change Notice
The SECURE ACT 2.0 passed and impacted many of the articles on this website. While the articles were correct when written, it’s impossible to re-write every article. Please consult a qualified professional (i.e., CFP®, CPA, or attorney) before implementing any strategy.